WHAT DO GREECE, Puerto Rico, China’s stock market meltdown, geo-political conflict, US rate normalisation, slowing EM growth, the downswing in oil and commodity prices, and the long arm of bank regulation have in common? Right: they’ve all been blamed for investor and bank skittishness and have caused market volatility and revenue reversals at corporates and banks.
Why, though, does no-one mention the collapse in leveraged finance activity in the same breath? Maybe it’s because you can see it as an effect of market malaise rather than a cause. That’s debatable, but either way it’s causing a lot of grief and I add it to my list of drivers of misery.
Financial sponsors and banks alike are being screwed by the triple-whammy of the uneasy market tone; over-zealous “guidance by menace” from US regulators around leveraged lending; and an M&A environment in which corporates are out-gunning private equity bidders on price and valuation.
Glancing through some of the Q2 earnings statements, leveraged finance was singled out by some banks as having dragged down overall debt underwriting revenues in an otherwise OK-to-so-so period for investment-grade activity. For banks whose debt businesses are axed around this segment, it’s hurting.
THE WAY THINGS are going, you’d expect current market conditions to continue, boding ill for revenues for the rest of the year at banks operating “high-beta” origination businesses. Who knows how leveraged borrowers will react to US rate normalisation? Corporate defaults aren’t showing particularly worrying signs but once those debt-service bills start to rise, you’ll see a spike in distress.
The numbers tell you all you need to know: 2015 vs 2014 YTD sponsor-backed loan volumes in the US – which accounts for around 70% of global activity – collapsed by 46% to US$162bn, according to Thomson Reuters LPC data. However you cut it, whether looking at the US or Europe (Asia is a rounding error), makes for painful reading.
Even if you take solace from the fact that Q2/Q2 US sponsor lending was down “just” 17%, Europe plummeted by half (to US$25bn) in the same period. The high-yield bond market is hardly helping: it’s been seeing significant spread volatility on news flow, and serious concerns remain around the prospects for the US E&P and related sectors, which has curtailed broad market access or transferred pricing power to the buy-side.
Global high-yield bond issuance year-to-date is down 17% at US$260bn; US high-yield flatters at –9% year-on-year but Q2/Q2 issuance by European borrowers was off 37% (to US$70bn). The current M&A dynamic has certainly squeezed LBO financing – down 40% in 1H15 to below US$31bn.
Naturally, there’s a linear correlation between market and wallet.
Banks are turning away business they would have jumped at until recently
NOTE THE FOLLOWING, after the release of Q2 numbers: Credit Suisse: “Debt underwriting results decreased compared with 2Q14, primarily driven by lower revenues in the leveraged finance business due to a slow underwriting environment, particularly in the US, and lower revenues in EMEA.”
Goldman Sachs: “Net revenues in underwriting were US$1.2bn, 6% lower than record results in the second quarter of 2014, due to lower net revenues in debt underwriting, reflecting lower leveraged finance activity.” Don’t be taken in by the grouping effect: debt underwriting suffered a 17% year-on-year decline.
Citigroup’s Q2 fixed-income investor review Q&A hosted by CFO John Gerspach, in response to a question about areas of lending the bank may pull back from: “We try to look very closely at every one of the activities that we’re involved in. I think you’ll note that we have been steadily moving down the league tables when it comes to leveraged finance, and so that might give you some indication of one of the areas at least that we would look at with somewhat less enthusiasm than others.”
JP Morgan: “Lending revenue of US$302m, down 32% YoY, primarily driven by losses on securities received from restructurings.” While that’s vague, it suggests turbulence at the hairier end of the leveraged spectrum.
UBS Q2 earnings call remarks by CFO Tom Naratil: “Corporate Client Solutions revenues were down 16% year-on-year, mainly in DCM, where leveraged finance revenues have decreased and the market fee pool declined 35% year-on-year.”
The Swiss bank reported a 51% decrease in its DCM line. While sub-segment revenue breakdowns aren’t disclosed, year-on-year revenues ex-levfi and self-led were up in the quarter, I hear. The chunky reversal was exclusively down to leveraged finance. Banks, it seems, are adopting a cautious stance around US regulatory guidance.
And that’s the point here: leaving aside the fact that backing sponsors at this point in the consolidation/asset-transfer cycle isn’t paying off, banks are turning away business they would have jumped at until recently.
This is why Jefferies ranked number one in the US LBO league tables in Q2 where as recently as 2013 the firm – which does in fairness have a decent leveraged finance practice – was operating at the bottom end of the top 10. It’s also why the likes of Macquarie Bank are winning deals.
These guys can still get in on aggressive highly-leveraged trades, which are verboten for regulated/insured banks. The sweet spot of mid-market deals also plays perfectly to the franchise strengths of these firms where they can wrap deals up even on a sole managed basis. This is also where private equity firms are prospecting for deals because they have a better chance of winning bidding contests.
Bottom line: it’s a win-win for the alternative lenders and the big boys, for once, aren’t able to fight back.
